Additional reminders about the Employee Retention Credit

ARTICLE | August 10, 2023

Authored by RSM US LLP

This article provides information related to the third quarter 2021 (Q3 2021) payroll tax deduction associated with the Employee Retention Credit (ERC). Credits relating to Q3 2021 are unique, because the statute of limitations for auditing the ERC related to that quarter’s credits is five years and the statute of limitations for amending the Q3 2021 payroll deduction is three years.

When applying the IAS 20 model by analogy, entities recognize the income statement benefits of the ERC when there is reasonable assurance (similar to the “probable” threshold in U.S. GAAP) that both of the following criteria are met: (1) any conditions attached to the program will be met and (2) the benefits (i.e., credits or cash) will be received and retained. Entities that apply an ASC 958-605 model by analogy recognize the income statement effects when conditions (barriers) are substantially met (overcome) by the entity. If as of the reporting date the recognition threshold under the analogized accounting model has not been met, any ERC amounts received (cash or credits) should be accounted for as a liability (i.e., a refundable advance). In general, such liability would be reversed only upon a successful IRS examination, expiration of the applicable statute of limitations, or upon repayment to the government.

When applying for the ERC, the entity must also reduce its previously taken payroll deduction for those payroll taxes by filing an amended income tax return and paying the related income tax. If upon examination, the entity is required to repay the ERC, it is reasonable to assume that the entity would amend its income tax return a second time to take the payroll deduction and accordingly record a receivable to recover the tax effect of the payroll tax deduction.

There is generally a three-year statute of limitations for amendments and audits of tax filings; however, an exception has been made to extend the statute of limitations to five years for credits claimed on Q3 2021 payroll taxes, without a corresponding increase in the statute of limitations for amending the related income tax returns. The issue, therefore, is that an entity may not be able to amend its prior income tax return if they are subject to an audit after the three-year statute of limitations expires but before the five-year statute of limitations expires on the Q3 2021 ERC. The receivable for the tax effect of the payroll tax deduction will be reversed when the three-year statute of limitations expires even though the deferred ERC liability would not be reversed until the until the five-year statute of limitation expires or the funds are repaid.

Entities with unrecognized ERC credits recorded as a liability related to Q3 2021 should consider the guidance in ASC 740 for uncertain tax benefits with respect to the recovery of the receivable for the tax effect of the payroll tax deduction. Entities should carefully consider whether the taxing authority will audit the Q3 2021 ERC claim within the three-year amended income tax return statute or after three years. Entities should analyze the more-likely-than-not probability guidance in ASC 740 and consider whether the receivable related to the payroll deductions from a second amended income tax return is recoverable. Such analysis should be performed, assuming the taxing authority has all knowledge of the facts and should not include an analysis of whether an audit by the taxing authority may or may not occur.

From a practical standpoint, under ASC 740, the evaluation of the more-likely-than not guidance is more complicated due to the different expiration dates of the receivable and the related ERC credit. Thus, entities must evaluate the likelihood of recovery of the receivable before the three-year statute of limitations expire and whether its recovery meets the “more-likely than not” threshold. Considerations include whether the entity will write off the receivable when the three-year statute of limitation expires or whether the receivable should ever be recognized. These considerations are unique to payroll deductions related to the Q3 2021 ERC claims, since at the end of the three-year statute of limitations, there will not be an offsetting reversal Q3 2021 ERC deferred liability.

This article does not conclude on the appropriate treatment of the receivable, as that conclusion must be based on the relevant facts and circumstances. Entities should ensure appropriate analysis and documentation is maintained to support their conclusions. Materiality of course, may also be considered.